A Letter of Credit (LC) is a document most often issued by a bank or other financial institution to secure funds on behalf of a beneficiary. The LC usually provides an irrevocable payment on behalf of the beneficiary however, sometimes payment can be revocable, confirmed, unconfirmed, transferable, etc. Payment to a beneficiary is governed by the terms included in LC, which most often require presentation and compliance of documents such as shipment notifications, bills of lading, etc.
In operation, when the beneficiary or a presenting bank acting on behalf of the beneficiary makes a presentation to the issuing bank or confirming bank, if any, within the terms of the LC, the confirming bank is obligated to issue payment. Most often, this presentation includes documents (e.g., shipping notification, bill of lading . . .) which satisfy the terms and conditions of the LC. In other words, once the LC is issued, the applicant cannot stand in the way of payment for any reason so long as the terms of the LC are satisfied. Essentially, the obligation to honor payment is shifted from the applicant to the issuing bank or confirming bank, if any. In some situation, non-banks can also issue LCs however, the risk is most often too high for a party to justify acceptance of such LCs.
In other situations, an LC can also be the source of payment for an international trade transaction. For example, oftentimes, an exporter will get paid by redeeming the LC. Today, international trade transactions of significant value often employ LCs to ensure payment. For instance, the LC lowers risk factors associated with deals between a supplier in one country and a wholesale customer in another. In these situations, it is not uncommon for the parties to not know each other. Thus, the LC provides a level of security in promoting such international deals.
Most all LCs are irrevocable and therefore cannot be amended or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if applicable. Typically, the documents a beneficiary has to present in order to avail themselves of the credit are commercial invoice(s), bill(s) of lading, insurance document(s), etc. However, as with any contractual relationship, requirements with respect to documents are open to imagination, negotiation and agreement.
As LCs continue to emerge as an important component of many business relationships, management of LCs has become an increasingly lucrative venture for banks and other trusted financial institutions. Unfortunately, many of the institutions are becoming so inundated with managing and tracking LCs that a majority of their resources are spent managing rather than increasing volume. Conventional systems used to manage LCs are a compilation of many different processes, many of which are manual book keeping leaving the door open to human error, inefficiencies and the like.